Article excerpt

ABSTRACT

Commerce is witnessing a governance shift from traditional vertical integration toward "virtual integration" (Sheth and Sisodia 1999) coinciding with a location-centric shift from marketplace to a more virtual "marketspace" via the proliferation of new marketing models based on electronic commerce. What exactly is virtual integration? Many use the term indiscriminately. This research has a two-fold purpose: 1) to more precisely define and explain the concept of virtual integration; and 2) to propose that the tenants of Transaction Cost Economics (TCE) used to explain conventional vertical integration governance might also be used to explain virtual integration.

The manuscript is grounded in TCE theory because of the theory's robustness in explaining structure in terms of governance. After a brief review of the theory, we define and explain virtual integration and present it as an alternative to market or hierarchical governance (i.e., make-or-buy), and offer a case study of the Dell Computer Corporation as an example of a virtually integrated firm who has successfully applied a new model of commerce, e-commerce. Lastly, we offer propositions reflecting TCE theory in an effort to apply Transaction Cost analysis in explaining virtual integration.

TRANSACTION COST ECONOMICS AND GOVERNANCE

Governance decisions often prompt the examination of the following make-or-buy question: should marketing functions be performed within the firm by owned employees (i.e., integrated), or should the firm rely on external agents (i.e., nonintegrated) to perform the activity? In other words, to what extent should the firm vertically integrate the performance of marketing activities (Anderson and Weitz 1986)? This governance choice defines the boundaries of the firm (Ouchi 1979) by determining the economic organization of the firm's activities.

According to Alchian and Demsetz (1972), two important problems face a theory of economic organization. First, to explain the conditions that determine whether the gains from specialization and cooperative production can better be obtained within an organization like the firm, or across markets. The second problem facing a theory of organization is to explain the structure of the organization. One economic theory of vertical integration which addresses these issues which has received strong empirical support is Transaction Cost Economics (TCE).

TRANSACTION COST ECONOMICS

Transaction cost economics, first suggested by Coase in 1937 (Coase 1998) as `comparative economic organization' and developed principally by economist Oliver Williamson (1975, 1979, 1981, 1985) is part of the "New Institutional Economics," a term coined by Williamson (Coase 1998). A key conceptual move for New Institutional Economics is to push beyond the theory of the firm as a production function (i.e., `Old Institutional Economics') into a theory of the firm as a governance structure (Williamson 1998). Transaction Cost Economics theory has diffused from its original development in economics to assume a prominent place in a broad range of scholarly inquiry (Bensaou and Anderson 1997).

Transaction Cost Economics focuses on the conditions under which a firm's function is more efficiently performed within the vertically integrated firm (i.e., hierarchical governance mode) versus open market contracting (i.e., market governance mode) with independent entities (Anderson 1984). As proposed by Williamson (1975, 1985, 1989), TCE is built on a micro-analytic framework with strong behavioral reality (Klein 1989. Anderson 1985). Transaction cost theory may be viewed in a general sense as a paradigm whose primary focus is the design of efficient mechanisms for conducting transactions (Heide and Stump 1995). The basic insights of TCE--that transactions must be governed as well as designed and carried out, and that certain institutional arrangements effect this governance better than others--is now increasingly accepted (Shelanski and Klein 1995, 336). …